Trailing 12-month default rates
Source: J.P. Morgan, as of May 31, 2021. Senior secured loans represented by the S&P/LSTA Leveraged Loan Index. High yield bonds represented by the ICE BofAML U.S. High Yield Index.
- By any number of metrics, the fundamental backdrop supporting credit markets today is a favorable one. Corporate earnings have continued to improve, a strong new issue market has been met by robust demand, and interest rates—and therefore debt service costs—remain low.
- Within this environment, default rates have plunged in recent months to 2.58% and 1.52% in the high yield bond and senior secured loan markets, respectively.1 As the chart highlights, these levels are at a 15-month low for high yield and 20-month low for loans as many of the large defaults from late Q1 and early Q2 2020 have rolled out of the trailing 12-month calculation.1
- Importantly, with an economy that has almost fully reopened, conditions appear to be in place to potentially sustain low default rates for some time.
- The compression in credit spreads2 since March 2020, rapid at first and more gradual recently, has been another sign of the supportive backdrop underlying credit markets. That sign, however, could cause consternation among investors who may presume that a correction must be imminent as spreads reach or near their post-Global Financial Crisis (GFC) lows.1
- Against this backdrop, it’s important for investors to remember that tight spreads do not beget imminently wider spreads. In the years leading up to the GFC, spreads remained between 250 bps and 400 bps in high yield—both considered “tight” levels—and within a 50 bps range in the loan market for over two years.1
- With spreads tight and yields low, however, finding returns can be difficult, especially for passive or benchmark-constrained investors. Such an environment may be ripe for research-driven active managers who are able to source deals and generate the potential for incremental above-market income.